Indian stocks fell as much as 5 per cent in Mumbai on Wednesday and prompted a fall in the rupee to a three-year low against the dollar on concerns over how India will finance its growing current account deficit.
Figures showing faster-than-expected economic growth of 9.3 per cent in the final January-March quarter of fiscal year 2005-06 raised expectations of further interest rate rises in July. Full-year growth in gross domestic product was revised up from 8.1 per cent to 8.4 per cent.
With India’s current account deficit still likely to reach an estimated 3.6 per cent of GDP in 2006-07, equivalent to $30.4bn, the government can ill afford a sharp drop in the capital inflows that finance the economy’s soaring imports bill.
India attracts little long-term foreign direct investment and has been relying on volatile inflows of hot money to finance its deficit. P. Chidambaram, finance minister, said India’s current account deficit was “manageable” but called for more FDI.
“While 8.4 per cent growth is satisfactory, more reforms are necessary to sustain that rate. If there are any hurdles to FDI, we must look at them sector by sector and remove them,” he said.
Reform of the banking sector alone, McKinsey calculates in a report out on Thursday, could lift GDP growth to between 9 per cent and 9.5 per cent. “Although India has several high performing private banks, they account for only 9 per cent market share,” says the report, Accelerating India’s Growth Through Financial Sector Reform.
“When things are ticking along nicely, with the country riding a demographic and consumption-led wave and enjoying the fruits of the 1990s reforms, it’s easy to defer doing anything more fundamental,” says Leo Puri, a director at McKinsey. “The debate is not about the wheels falling off, but more the lost opportunity.”
Mirroring sell-offs in other emerging markets, the main BSE Sensex index on Wednesday closed down 388 points at 10,399, a fall of 3.6 per cent. The broader Nifty index was also off by 3.6 per cent, dropping 114 points to 3,071.
Chetan Ahya, an economist at Morgan Stanley, said: “India is being affected more than others because it got a disproportionate share of inflows from dedicated emerging market funds.”
The sharp equity market sell-off is a continuation of the mini market meltdown that began on May 12, when foreign institutional investors started to trim their exposure to India, along with other emerging-market economies.
Foreign funds have been net sellers of cash equities for each of the past 11 trading days and have reduced exposure to Indian equities by $2.5bn since the Mumbai stock market reached its all-time high of 12,671 on May 11.
The index is now down 18 per cent from its recent peak, a decline that for unhedged foreign investors will have been compounded by the steep fall in the value of the Indian rupee.
Net portfolio inflows remain positive, at $2.49bn since the start of the year, but a continuation of recent outflows will hit the currency, with analysts at JPMorgan predicting it will slip to 47.5 to the dollar by year-end.